What led to the rise in acceptance of the views of Friedrich Hayek and the Chicago School?

An economy is ultimately built on trust. If society trusts the system, then the system will remain. In the latter half of the 20th century, after a Golden Age of economic prosperity, the system of many capitalist countries began to collapse[1]. The economic policy of these nations was termed the ‘Keynesian Consensus’ (KC) – a belief that government spending and a goal of full employment would result in an ideal economy. Trust in this system ended in the 1970s, when warning signs of inflation reached a peak during the Oil Crisis[2]. Coupled with a crisis termed ‘Stagflation’, the KC had seemed to have failed[3]. The Chicago school, ultimately, filled the vacuum which the failure of the KC had left. A variety of events caused the collapse in the KC and the rise of Neoliberalism: the Oil Shock, collapse of Bretton Woods, Stagflation and the rise of strong leaders who believed in Chicago school principles.

The collapse of the Bretton Woods System was the first loss for the KC. The system wherein signatory nations would have their currency pegged to the dollar had started to hold nations back. Without freedom to determine monetary policy, nations such as France had begun to suffer. After the Vietnam War had shook trust in the dollar, many nations wanted to leave. In 1971, President Nixon put an official stop to the Bretton Woods system with his announcement that the US would be “temporarily suspending” their pegging to gold.[4] With the confines of Bretton Woods thrown off, countries could now stimulate their economies.[5] One of the major policies of the KC had been revoked.

The Oil Crisis of 1973, sparked by the Yom Kippur War, sent the price of oil skyrocketing.[6] Inflation had already been steadily rising but confidence in the KC was so profound that politicians refused to act on it.[7] This ended when OPEC (Organization of the Petroleum Exporting Countries) raised oil prices dramatically. As a result, inflation was growing harsh enough that it could threaten society.[8] With a second oil crisis following the Iranian Revolution, inflation became a real threat to the economy – one unprecedented by the KC.

Stagflation posed a real conundrum to the KC as in their ideology, it should not be possible. Its existence further delegitimised the Keynesian view. While Keynes believed that inflation was a mere trade-off for the ideal of full employment, America and the world was facing a predicament of stagnation in the economy, causing unemployment, coupled with high rates of inflation.[9] After the Oil Crises, Presidents such as Carter could no longer ignore inflation as a harmless by-product of Keynesian policy. Stagflation threatened the economy and people had lost trust in the KC.[10] It was only with Paul Volker, Chairman of the US Federal Reserve in 1979, that a concerted effort was made to fight inflation. Volker, as a monetarist, limited the money supply, halting growth of the economy. The public hated him for causing a major recession, but eventually – Volker conquered inflation. This triumph of Monetarism over Keynesianism was another nail in the coffin for the KC.[11]

With Keynesianism facing harsh distrust, a vacuum needed to be filled – the Chicago school and Neoliberalism (a belief in the efficiency of free markets) filled that vacuum. Friedrich Von Hayek had previously been thrown into obscurity but after being awarded the Nobel Prize for Economics in 1974, his ideas began to gain new legitimacy.[12] Hayek distrusted the ability of the state to manage an economy, and with his book “Road to Serfdom”, he illustrated the dangers in allowing it to do so.[13] Hayek’s influence on Chicago University and its thinkers led to it becoming a beachhead for the fight against central planning and the KC.[14] One such thinker was the economist, Milton Friedman who attended Hayek’s 1947 meeting at Mont Pelerin.[15] Friedman later became a professor at the University of Chicago and led the popularisation of the Chicago School, a belief that government intervention was dangerous and that the free market was ultimately the most efficient economic system.[16] Friedman’s popularity with academic and mainstream markets due to his controversial thinking and charisma led to permeation of the Chicago School into mainstream thinking.[17]

It was Friedman’s influence, with the legacy of the Road to Serfdom, which led to Margaret Thatcher becoming a strong proponent for free markets. Thatcher believed in the failure of government and the virtues of the free market.[18] She battled the unions and led the privatisation of many underperforming state-companies.[19] Across the Atlantic, President Reagan was leading the free market charge with what was termed ‘Reaganomics’. These policies were not as radical as Thatcher’s, mostly due to his inability to cut spending, but did spearhead dramatic economic growth.[20]

The rise of the Chicago School and capitalist leaders such as Reagan and Thatcher is testament to the failures or belief in the failures of Keynesianism. The Oil Crises contributed to economic downfall but the presence of stagflation and collapse of the Bretton Woods system contradicted much of the KC ideology. This gave way for free market advocates such as Hayek and Friedman to give rise to Neoliberalism and the Chicago school, which then influenced world leaders such as Thatcher and Reagan. Overall, the rise of Neoliberalism can be seen as a result of the failure of Keynesianism to formulate a sustainable economic system.